Why Your Portfolio Needs Private Diversification

In today’s world, where companies stay private for as long as possible, it’s tough for stock investors to find fairly priced growth investments.

As you can see from the chart below, the U.S. IPO market is not what it once was.

EI_ipo market_sm

The dark blue line represents IPOs raising less than $50 million. These types of opportunities once formed the core of any investor’s growth portfolio.

Unfortunately, these small cap growth stories, formerly the lifeblood of wealth creation, have been decimated. Today, it simply doesn’t make sense for most companies to go public until their “mega-growth” periods are over and insiders are looking to cash out.

This is especially true for fast-growing tech companies. My point is clearly illustrated in the chart below, courtesy of top-tier venture capital firm Andreessen Horowitz.

EI_tech funding_sm

In 1995, roughly 80% of tech company funding came from public markets. In 1997, when Amazon (Nasdaq: AMZN) went public, that number was still over 65%.

Investors who bought into Amazon at the IPO price have seen returns of 24,000% since.

But an early IPO like Amazon’s would simply never happen today.

In fact, the number of U.S. public companies is actually shrinking, as reported by Bloomberg in a piece titled “IPOs Get Bigger but Leave Less for Public Investors”:

The number of U.S. companies taking their shares off public exchanges has exceeded the number of new listings, causing the ranks of public companies in the U.S. to fall 36% since 2000, according to the World Federation of Exchanges.

As legendary venture capitalist Marc Andreessen puts it, “Gains from the growth accrue to the private investor, not the public investor.”

Primarily at fault here is a piece of legislation called Sarbanes-Oxley, which I wrote about in July. That law was passed in the wake of the Enron implosion. It made going public a far more expensive endeavor and forever changed the landscape for growth investors.

It also rigged the game in favor of wealthy investors, who all of a sudden had exclusive access to the fastest-growing companies. Whether that was intentional or not, we’ll likely never know.

The end result, however, is summed up well by the Bloomberg article I referenced earlier:

Initial public offerings used to offer investors chances to get in on the ground floor of young, fast-growing companies…

These days IPO investors are more likely to get in somewhere around the sixth floor, when companies are well beyond infancy and maybe approaching middle age.

“Sixth floor opportunities”… Doesn’t have a very nice ring to it, does it?

Fortunately, we now have equity crowdfunding.

It’s the only viable way for U.S. investors to access early-stage, high-growth opportunities.

There’s more risk here, naturally, but far more potential reward. When you’re investing in companies valued at $1 million to $50 million, the gains can be stunning.

But make no mistake, this is far from blue chip investing. There are no consensus analyst “buy” ratings here.

And investors should be ready for some of their companies to fail and return only a portion of invested capital (or nothing). It’s simply part of the math of private investing.

Finding success at these early stages requires diversification, research, experience and patience.

So if your investment horizon is longer than seven years or so, putting in the work to understand equity crowdfunding will be more than worth the time.

Like it or not, this is the future of growth investing. Due to Sarbanes-Oxley, nearly all the “hyper-growth” now happens in private markets.

This is exactly why we launched our new research service, First Stage Investor. We handle all the research, and we have the experience to spot a good deal when we see one.

So far, we’ve grown to have close to 5,000 members. Already, we’ve been able to secure exclusive first access for our members to a hot upcoming equity crowdfunding deal.

This is just the beginning of what we’re offering to members.

Good investing,

Adam Sharp
Founder, Early Investing